Blockchain as a Macroprudential Solution

In order to understand why Blockchain could be a probable solution, we will need to examine the revolution that blockchain was able to “solve.”

The continued rise of the Blockchain has many individuals scratching their heads. Many are able to wrap their heads about the use of strong cryptographic nature of Blockchain such as SHA-256 but are puzzled at the application. Mainly the use of Blockchain in the form of Bitcoin the cryptocurrency. How can something that is so simple having such a great impact on the financial and computer science world?

Byzantine General’s Problem

The answer lies in the Byzantine General’s problem, partially game theory, partially computer science. It was a huge issue within computer science for decades, computer scientists have for many decades failed to create trustless systems. The banking system relies on a system known as Web of Trust. It requires that centralized systems, which can be hacked or sabotaged carry out the balancing of books. Although it is exhaustive, it requires the trust to function.

Elaborating

The Byzantine General’s Problem is a classic problem. Imagine that there are 6 generals that are converging onto one location, an enemy’s castle. If all 6 generals lay siege to the castle at once, they will surely win. However, even if 1 general breaks rank and decide to not help, everyone loses. All 6 generals have armies that are allied but are independent of each other in a chain of command, and all 6 generals have WhatsApp on their phones and can contact their counterparts. The Byzantine General’s Problem occurs, how can we ensure that everyone acts in the same manner, in one consensus?

In 2008, an unknown entity/individual known as Satoshi Nakamoto released an 8-pager titled Bitcoin: A Peer-to-Peer Electronic Cash System. In his paper, he advocated Bitcoin as a digital cash system which uses Proof-of-Work coupled with a Blockchain (Nakamoto, 2008). The Blockchain [introduced as a component of Bitcoin] is a distributed consensus which in the Byzantine General’s problem attempt to have all 6 generals sign a message, verifying that each general’s message is true and inviolable. If 1 general tries to cheat the messaging system by sending attack orders to 4 other generals and stop orders to 1 other general. The consensus will be skewed. Bitcoin which utilizes a blockchain elegantly eliminates the possibility that any messages can be forged. The ledger is public, verifiable, trustless, and inviolable [SHA-256].

Will Bitcoin replace Fiat?

Contrary to popular belief, a Bitcoin [as it stands today] will never be a replacement for fiat currency, it attempts to be but it will fail as it depends on cryptographic properties of computing power. It will always be less efficient than a printed dollar and will be slower than someone handling a dollar to another [explained shortly]. The value proposition of Bitcoin is the advocacy of trustless based system and tries to address the trust-based financial intermediaries that are too big to fail.

In order to understand how a Blockchain works, there is a need to look into the inner workings of Bitcoin. We will examine the Nakamoto Consensus in the next post.